01 POWER ISLAND / 01 CCPP / DOE__Understanding Natural Gas and Lng Options October 11 2017_1

LNG AND GAS CONTRACTS

Consequently, care should be exercised in entering into any preliminary documents and their use should be limited to only situations where deemed commercially essential.

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Domestic Gas Sales Agreement

The domestic Gas Sales Agreement (GSA) follows the typical pipeline gas sales agreement format, with the following key points:

Commitment

The issue is whether the domestic buyer will have a firm "take or pay" commitment under which they are required to pay for supply even if they are unable to accept delivery, or a softer reasonable endeavors commitment. If it is only a reasonable endeavors obligation, the question arises whether the domestic buyer forfeits the right to the committed volumes if delivery is not taken on schedule. By contrast, the LNG plant developer will want to secure gas supply for the liquefaction plant. This includes a take or pay commitment and reserves certification.

The commitments of the seller and the buyer should be balanced.

Price

Pricing of natural gas going to the liquefaction plant may depend on the structure of the LNG chain, whether it is integrated, merchant or tolling. The price may be indexed or may be fixed, with or without escalation. If the structure of the LNG export project is integrated, there is generally not a transfer price between the upstream and LNG plant for the gas feeding the

LNG plant. Similarly, the domestic gas price can be fixed and/or regulated, or negotiated between buyers and sellers.

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Payment

Domestic gas contracts can be priced in the local currency and this can give rise to foreign exchange risk for the investors involved. Payment currency risk analysis should be an ongoing process. Gas sales for exported LNG are typically priced in dollars, however, the trend in domestic gas sales worldwide has been that payment is typically made in the local currency.

Other elements of a standard GSA include Definitions and Interpretation, Term, Delivery Obligation, Delivery Point and Pressure, Gas Quality, Facilities and Measurement, General Indemnity, Dispute Resolution, Force Majeure, Suspension and Termination, General Provision, Warranty, and Indemnities.

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LNG Sale and Purchase Agreement

The LNG Sale and Purchase Agreement (SPA) is the keystone of the LNG project bridging the liquefaction plant to the receiving regasification terminal.

There is no worldwide accepted model contract for a SPA, with most major LNG sellers and LNG buyers having their own preferred form(s) of contract. Some international groups, including The International Group of LNG Importers (GIIGNL) (www.giignl.org) and the Association of International Petroleum Negotiators (AIPN) (www.AIPN.org), have prepared model form short-term contracts, e.g. AIPN has a model form LNG master sales agreement.

Most LNG SPAs have become lengthy and very detailed documents. However, the main points of an LNG SPA can be summarized below:

Commitment

The commitment made in a SPA, in its broadest sense, is epitomized by the

following statement: The seller commits to sell and the buyer commits to purchase.

The elements of the commitment are term, transportation, volume, level of commitment and ability to divert LNG cargoes.

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Term

Historically, LNG SPAs have been long-term contracts with terms of 20-25 years. These long-term contracts were needed by both the seller and the buyer to justify the significant investments required by the liquefaction project and by the receiving terminal and the natural gas end-users. The majority of the throughput of the liquefaction plant needs to be tied into these long-term contracts to enable the developer (see the chapter Financing an LNG Export Project) to secure project finance. As the LNG industry has grown and LNG supplies have become more readily available, there are now some shorter term contracts (5-10 years) for a minority percentage of throughput, but long-term SPAs are needed to underpin financing. Additionally, a growing spot market for LNG has developed as a result of several unforeseen factors:

>The development of many global LNG export projects to meet expected U.S. demand (at the end of the 1990s and the beginning of the 2000s) where the cargoes were subsequently available to other global markets.

>The availability of re-exported LNG cargoes from the U.S. and other countries due to reduced demand.

>The development of tremendous quantities of shale gas in North America and the resulting reversal of a large import destination to an emerging exporter.

>The Fukushima nuclear accident following the 2011 tsunami and earthquake, the consequent increased demand for LNG in Japan and the uncertainty of the timing of the re-start of their nuclear power plants.

>The collapse in oil prices in 2014/2015.

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Transportation and Discharge

LNG sales can be done on a FOB (free on board) basis, with the buyer taking title and risk at the liquefaction facility and being responsible for transportation of the LNG; CIF (cost, insurance and freight) basis, with the seller being responsible for delivering the LNG to the tanker at the liquefaction plant. The buyer assumes title and risk, but the seller is responsible for the costs of transportation to the destination or DAT (delivered at terminal) or DAP (delivered at place), with the seller retaining title and risk until the LNG is delivered and the seller being responsible for transportation. The terms DAT and DAP replace the delivered ex-ship (DES) terminology that may still be encountered in some forums.

Volume

The SPA will specify the volume of LNG that the seller is obligated to deliver, and the volume the buyer is obligated to take, each contract year (generally a calendar year), and provide a process for scheduling and delivering this volume in full cargo lots aboard agreed upon shipping. The SPA will provide for certain permitted reductions to the committed volume. For example, this would include volumes not delivered due to force majeure, volumes not delivered due to the seller's failure to make them available, and volumes which are rejected because of being off specification.

Level of Commitment

The level of commitment being taken on by both the seller and the buyer is important to understand. If the commitment is "firm," a failure by the seller to deliver or by the buyer to take the LNG would result in exposure to damages. If the commitment is "reasonable endeavors," damages would probably not result.

LNG SPAs are almost always founded on a "take or pay" commitment, where the buyer agrees to pay for the committed volume of LNG, even if it is not taken, subject to the right of the buyer to take an equivalent make-up volume at a later time. Take or pay has been the cornerstone of an LNG SPA since the beginning of the industry and likely will continue into the future. However, some LNG SPAs now use a mitigation mechanism,

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whereby the seller sells cargos not taken and charges the buyer for any reduction in price, plus the costs of sale.

Similarly, the seller seeks to limit its exposure in a shortfall situation - where the seller does not deliver the full commitment - to something less than full damages. Often the seller will be responsible for a shortfall amount calculated as a negotiated percentage (15%-50%) of the value of LNG not delivered, with this amount paid either in cash or as a discount on the next volumes of LNG delivered.

These features, although detailed in nature, can typically involve financial commitments of hundreds of millions of dollars, and are therefore to be negotiated carefully, with the benefit of expert advisors.

Cargo Diversions

Recent LNG SPAs contain the right to divert a cargo to a different market. Where the seller or the buyer diverts a cargo, it is generally done to obtain a higher price. Two key points to address in situations of cargo diversions are the allocation of non-avoidable costs between the parties (e.g. receiving terminal costs, pipeline tariffs, and damages for missed natural gas sales) and whether and how the parties should share in the profit obtained through the diversion sale. This later point may entail anti-competition exposure in some countries.

Price

At the time of writing this handbook, LNG pricing formulas are evolving from largely oil-linked pricing to largely gas-linked pricing, although the full evolutionary process is still underway. As a result, there are various mixed pricing formulas in use, including pricing techniques that modulate fluctuations in oil pricing, such as an "S" curve.

One important trend in pricing is the emergence of 'pricing review' clauses in LNG SPAs, where the LNG price can be examined and changed at periodic intervals if specified market conditions are triggered. While the intent of these clauses is to preserve a link between a long term contract

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and the actual market pricing, such clauses can be very contentious and lead to disputes between sellers and buyers.

Technical

Technical provisions to be included in an LNG SPA include provisions on minimum and maximum specifications for LNG (including heating value and non-methane components), measurement and quality testing of LNG, LNG vessel specifications and requirements, receiving terminal specifications and requirements and provisions for nomination and scheduling of cargos.

Miscellaneous

Aside from the above key components, an LNG SPA would typically include:

>Provisions for invoicing and payment

>The mechanism for delivering gas feedstock into the liquefaction facility

>Currency of payment

>Security for payment, including prepayment, standby letters of credit and parent company or corporate guarantees

>Governing law of the LNG SPA, which typically will be England or New York

>Dispute resolution through international arbitration

>Conditions precedent

>Definitions and interpretation

>LNG quality

>Testing and measurement

>Transfer of title and risk

>Taxes and charges; liabilities

>Force majeure

>Confidentiality

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Miscellaneous Agreements

There are a number of other key agreements that might be necessary for an LNG project, depending on the structure selected. The following is a representative list:

Project Enabling Agreement

Unless specifically authorized by legislation (law) or enabling regulations, a liquefaction project will require some sort of project enabling agreement between the host government and the project sponsors. This project enabling agreement will describe in detail:

>The scope of the liquefaction project to be undertaken.

>The legal regime and the tax regime to which the liquefaction project will be subject, including any tax incentives or exemptions benefiting the liquefaction project.

>The ownership of the liquefaction project, including any reserved local ownership component.

>The governance and management of the liquefaction project.

>Fiscal requirements applicable to the liquefaction project.

>Local content requirements and procurement procedures applicable to the liquefaction project.

>Government assistance including in connection with acquiring land and other licenses and permissions.

>Any special local terms and provisions.

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Shareholders Agreement(s)

If an incorporated special purpose vehicle (SPV) is to be used, the agreement of the shareholders regarding governance and management will need to be documented in a Shareholders Agreement. The Shareholders Agreement complements and expands on the Articles of Incorporation or other constitutional documents of the SPV.

Liquefaction Agreement

If a tolling structure is selected, the liquefaction tolling entity will need to have a contract outlining the services to be performed, the tolling fee structure for such services and other provisions regarding risks, etc. with the natural gas customer. This agreement may go by many names, including liquefaction agreement and tolling agreement.

Gas Feedstock Agreement

If a merchant structure is selected, the merchant liquefaction entity will need to purchase the natural gas to be liquefied in the liquefaction facility. The most contentious issues in the gas feedstock agreement are: (1) the transfer price for natural gas, with the gas seller typically wanting a netback price and the liquefaction entity wanting a fixed price, and (2) the liability of the natural gas supplier for any shortfall in deliveries, with the gas supplier wanting to limit liability and the liquefaction entity wanting a passthrough of its LNG SPA liabilities.

EPC Contracts

The engineering, procurement, and construction contract(s) for the upstream facilities and the liquefaction facilities will need to be negotiated and entered into by the appropriate entity, depending on the project structure.

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